Fitch stated that banks are exposed to risks from growth in retail loans, MSMEs exposure and vulnerable corporate sectors.
Fitch Ratings has changed its outlook on Indian banks operating environments (OE) from negative to stable, because it believes that the country’s ongoing recovery will support sustainable business growth.
Financial performance risks have been reduced due to the decreasing risk of pandemic-related disruptions.
These factors are the basis for the current OE score (bb), which is two notches higher than the implied category score (b), the global rating agency stated.
Fitch predicts India’s economy will outperform its peers and projects real GDP growth of 8.4 percent for FY22, and 10.3 percent for FY23.
The agency expects stable medium-term earnings from public sector banks (PSBs) as near-term improvements are offset by the end of regulatory forbearance for the financial year ending March 2023. (FY23).
It was observed that forbearance has lowered PSBs immediate capital needs by deferring the recognition of stress, giving banks enough time to build capital buffers.
Fitch predicted that large private banks will increase market share due to their better capitalisation and ability to sustain higher loan growth. This is backed by solid retail franchises as well diversified businesses and stable funding.
SBI is considered the most competitive State bank due to its vast reach, dominant franchise and relative pricing power. This should partially offset some of its capital limitations.
However, State banks are likely not to enjoy a significant market share due to their low capital buffers that limit loan growth, insufficient pricing power and weak execution of management, said the agency.
Governments support
Fitch pointed out that banks will also be able to benefit from forbearance measures, such as State-guaranteed funding in an emergency and the option of restructuring loans.
This will limit risk to earnings and asset quality, and allow banks to build capital buffers before asset-quality risks re-emerge after forbearance begins to unwind in 2023, according to the agency’s peer review of Indian banks.
Fitch expects the gradual unwinding unrecognised stressed loan debts to create moderate asset-quality stress starting in FY23. It said that private banks will fare better than public banks because they have more earnings headroom.
Our negative outlook on ICICI’s asset quality is due to its higher exposure and loans under forbearance, than at peers.
SBI and Bank of Baroda are less at risk than other State banks. However, a lack of pandemic-related provisions may pose challenges, according to the agency.
Retail and MSME stress
The agency expects that the majority of stress will come from granular loan segments. These include retail and micro and medium-sized businesses (MSMEs).
Fitch believes that retail loans have seen a significant increase in growth and that MSMEs and vulnerable sectors of the corporate sector have exposed them to risks that cannot be captured in the improved impaired loan ratios that result from regulatory forbearance.
The agency expects that underwriting will eventually be tested, with the gradual unwinding and recognition of unrecognised stresses post FY23.
This will likely happen alongside a gradual increase in risk appetite across banks as a response to the economic recovery. It added that this will result in a greater risk density, which is higher than multi-year lows.
The agency acknowledged that there would be some stress in pandemic-affected corporate sectors, such as travel and hospitality. However, it considers corporate loans less risky due to the risk aversion demonstrated by banks in recent decades.
Fitch stated that retail loans have lower risks due to the high percentage of secured loans. However, banks with higher exposure to unsecured loans and loans to self-employed borrowers could face difficulties.
It considers MSMEs to be the most vulnerable, while corporate loans are more resilient thanks to a prolonged period deleveraging and India’s economic recovery.
High exposure to vulnerable sectors is indicative of state banks’ greater risk appetite. However, we believe the share of corporate loan could increase due to the infrastructure and construction sectors. This is in light of the government’s strong focus in infrastructure spending.
The agency stated that banks should be cautious considering the significant losses they have suffered from this type of financing in the past.
Earnings revival
Fitch expects that earnings and profitability will recover at most banks by FY23. This is due to falling loan-impairment fees (H1 FY22 system average: 1.2% of loans, FY21 average: 1.7%), and forbearance, which will limit new loan impairments.
The ability to recover from impaired loans should be a factor in reducing pressure. Earnings should also be supported by adequate pre-provision profits (H1 FY22: 3.6%, FY21: 3.5%) due to stable net interest margins.
Waning forbearance will likely pressure profitability, but we expect average operational profit/risk-weighted asset to remain comparable to banks’ current earnings and profitability scores.
Fitch noted that earnings of private banks should continue outperforming those of PSBs, aided by higher preprovisioning income buffers.
Private banks are able to offer more lucrative loan mixes and diversify their income base, which is why this trend is occurring. The rating agency stated that any increase in loan impairment fees after forbearance is unwinds should be partially offset by strong loan growth and rising fees income amid steady cost/income ratios.
Published on
March 11, 2022
